The US Housing Finance System: A Flawed Giant

Tuesday, July 02, 2019 | Don Layton

It is well understood that housing, broadly defined, generates a tremendous share of US GDP – roughly one-sixth in fact, with only the healthcare sector being larger. And for the average family, housing is a very big part of life – monthly payments for owning or renting a home are classically regarded as the biggest item in the average household budget.

And to have America’s people housed well, it is necessary to have a quality housing finance system to help make it all work. In aggregate, housing finance is similarly a tremendous share of the country’s financial system – there are about $11 trillion in residential mortgages outstanding today. As a measure of how large this is, the entire deposit base of all FDIC-insured banks in the country amounts to about $13 trillion, which is not that much more.

In 2012, I came out of retirement to become the Chief Executive Officer of Freddie Mac, one of the two large government-sponsored enterprises (GSEs) that together back between 40 and 50 percent of America’s residential mortgages; it is one of the most powerful and central positions in housing finance. This was, to me, a public service position as much as a corporate one, as the company had been under the control of the US Government for about three and a half years at that point (and still is today, seven years later). As background, I had a long career in banking and financial services, with broad experience managing financial institutions, in particular at JPMorgan Chase, where I had spent 29 years, starting as a trainee at one of its predecessors and rising to become one of its top three executives. I was not a mortgage “lifer” but had significant mortgage experience throughout my career. Additionally, and helpfully, I had a particularly strong quantitative finance background, both from my career and from my long-ago time as a student at MIT and Harvard.

In taking the position, I learned that there were two very different views of the country’s housing finance system among government officials (including elected ones), the industry, housing advocacy organizations, and the broad policy community found in Washington.

One view was sympathetic and positive. The housing finance system, most of which was assembled by the government beginning in the Great Depression, was regarded as enabling the broad middle and working class to become homeowners on a large scale, in much greater numbers than existed before the Depression. (Such homeownership is almost universally regarded as a strong social and economic positive, allowing family wealth creation and building strong communities, among other benefits.) The US housing finance system was heavily built on what became known as the “American” mortgage – a 30-year, fixed-rate mortgage that can be prepaid at any time with no penalty, and which can have its rate locked in ahead of time. (This type of mortgage does not substantively exist anywhere else in the world.) And all at a relatively low cost, compared to other long-term market rates, such as US Treasuries.

The other view is not sympathetic at all; it is quite negative. This counter view is that the housing finance system is a mess. It’s a hodge-podge of overlapping and competing institutions, some of which are in the private sector, some are directly run by parts of the US government (like the Federal Housing Administration) and some are hybrids (like the GSEs). It points out the overt and covert subsidies flowing through the system, often amazingly large in size, which are not transparent or ever approved by Congress. It highlights that the only two major financial crises in the US since World War II were centered on the mortgage system – the 1989 Thrift Crisis and the 2008 Financial Crisis. And it highlights the excessive role government plays in housing finance, accounting for about two-thirds to three-quarters of all single-family residential mortgages, which has brought along with it – and this should not be a surprise – an unusually large focus on lobbying and political engagement by virtually all housing finance organizations; books, articles, and Congressional testimony have documented how such politicization was often quite unseemly. In fact, in this view, the proper economic decision-making needed for an effective and well-run housing finance system has been incredibly distorted by political considerations at almost every turn, to the detriment of the taxpayer and the stability of the financial system.

So, which is it?

What I found, after having spent seven years at the very heart of the housing finance system as Freddie Mac CEO, is that both views are true at the same time, and have been for decades.

In becoming a Senior Industry Fellow at the Joint Center for Housing Studies, I will be writing about housing finance. My approach in doing so will be that of the classic technocrat, writing on an expertise basis rather than an ideological or a special interest one. (A former head of the New York Federal Reserve Bank once called me the most pragmatic person he knew. I took it as a compliment.) In addition, I have observed over these past seven years how there is, for whatever reason, a tremendous knowledge gap; what I, as a direct participant, know to be the facts and actual happenings in housing finance are not readily known among others in the housing finance system, much less the interested general public. Unfortunately, inaccurate or distorted versions of reality often seem to dominate public discussion, which is distressing because, without the real facts, how can we expect government to do a good job on housing finance?

In monitoring articles and speeches in the housing finance policy community these last seven years, I have been struck by how many of them advocate based on political philosophy, how many of them (even when well-intentioned) suffer from being on the wrong side of the knowledge gap, and how many are driven by special interests looking to maximize cash flow and power. As a pragmatist, that’s not how I will approach my writings. Based upon my long career in banking and finance, plus my seven years at the heart of the US housing finance system, I have come to the view that the facts support that the government has a real role to play in making housing finance work well for the American people and that such a role should be preserved. I have also come to the view that surrounding that role is an incredible amount of “bad stuff” – the rampant lobbying to create distortions that in turn deliver excessive cashflow to special interests (called “rent-seeking” among economists), unsafe and unsound practices, never-approved and hidden subsidies that are an affront to the taxpayer – and that it is indeed possible to eliminate the bad stuff while preserving the core positive role the government plays.

My writings over the coming year will vary in length from short, quick hits to longer essays more fully exploring issues in significant depth. One series of articles will directly address current proposals for housing finance reform, especially of the GSEs. My goal will be to help the proposals be more solid, more likely to work as intended instead of being a source of the classic government “unintended consequences.” Another series will be focused more long-term, describing the “political economy” of the mortgage system, i.e. the intertwining of economics and politics that historically has dominated the system and heavily distorted much of it. These articles will describe the harm caused by the excessive politicization, hopefully with some practical and implementable suggestions of how policymakers can reduce the role of special interest politics in the system while maintaining its advantages. And, of course, there will be one-off articles from time to time as seems called for.

For the past sixty years, the Joint Center for Housing Studies has been a respected and non-partisan institute of scholarship about housing. I’m honored they have invited me to be a fellow and I look forward to sharing my thoughts on these and other issues of importance to housing policy in the US.

Subscribe to our blog

Receive our newest blog posts in your inbox

About JCHS

The Harvard Joint Center for Housing Studies advances understanding of housing issues and informs policy. Through its research, education, and public outreach programs, the Center helps leaders in government, business, and the civic sectors make decisions that effectively address the needs of cities and communities. Through graduate and executive courses, as well as fellowships and internship opportunities, the Center also trains and inspires the next generation of housing leaders.